Question:
The following information appeared in the 2002 annual report of Lyondell Petrochemical Company, a manufacturer of petrochemicals and refined petroleum products such as gasoline, heating oil, jet fuel, aromatics, and lubricants: The Company is party to various unconditional purchase obligation contracts as a purchaser for products and services, principally for steam and power. At December 31, 2002, future minimum payments under these contracts with non-cancelable contract terms in excess of one year and fixed minimum payments were as follows ($ in millions):
2003 $164
2004 168
2005 169
2006 157
2007 151
Thereafter 1,749
Total minimum payments $2,558
Required:
1. Suppose that the company is obligated to purchase $349.8 million per year in 2008 and each of the next four years for a total of $1,749. If Lyondell’s normal rate of interest for a 10-year loan is 8%, what is the present value of the company’s purchase commitments?
2. The company’s 2002 balance sheet shows long-term debt of $3,926 million and shareholders’ equity of $1,179 million. The unconditional purchase obligation is not shown on the balance sheet. What impact would including the present value of unconditional purchase obligations as part of long-term debt have on the company’s 2002 ratio of long-term debt to shareholders’ equity?
3. Why are unconditional purchase obligations an off-balance-sheet liability? Why might some companies prefer to keep the purchase commitment off the balance sheet?